BGR,
I'll make a brief attempt at "my" concept fair value.
The books will tell you that "fair value" is the present value of the future free cash that can be taken out of a business over its lifetime discounted at an appropriate interest rate.
Personally, I like the concept of replacement cost, business position, and sustainable return on capital. It should give you the same answer but in a less complicated fashion.
A business that can be expected to generate rates of return on its invested capital that are appropriate given the "business" risks is worth its replacement cost. Any significant deviation in price or return from that level will tend to encourage or discourage investment and drive the price and returns up or down to their appropriate level. Over time then, replacement cost will approximate the value. I would think that the country as a whole would tend to move towards this level.
Unfortunately, the world is not so neat. Replacement costs are hard to estimate and so are business positions.
In addition, some companies have superior business models, management, brands, size, or other sustainable advantages. These advantages allow them to generate sustainable excess returns. This goodwill makes them worth more than their replacement cost. Similarly there are companies that possess ill-will instead of good will.
But sometimes the prices and fundamentals are so far apart that there is enough of a difference to say that a company is overvalued or undervalued.
Wayne |
